Kill the Q: Subprimes Head for Balance Sheets

FASB this week will work on a plan to require that banks ditch the "lockboxes" that hold securitized assets.
David M. Katz, CFO.com | USJune 2, 2008

(CORRECTION: This is a corrected version of a story that inaccurately reported that the Financial Accounting Standards Board was likely to consider the elimination of Qualified Special Purpose Entities. In fact, the board decided to remove the concept of QSPEs from FASB Interpretation No. 46 at its April 2 meeting.)

On Wednesday, the Financial Accounting Standards Board is likely to consider language to eliminate Qualified Special Purpose Entities (QSPEs) and look at how their assets and liabilities should be consolidated on the balance sheets of the financial institutions that set them up, FASB chairman Robert Herz said at a webcast on the subprime crisis on Monday.

Banks and other firms have made improper use of QSPEs in securitizing prepackaged loans, Herz had said in April. With the elimination of QSPEs, companies will be required to review whether all special purpose entities — the trusts used to hold securitized assets — need to be brought back on to the balance sheet under the accounting rules laid out by FASB Interpretation 46R.

Under FAS No. 140, FASB intended the "Qs," as they're commonly known, to hold onto their assets in a passive way, said Herz during the webcast, comparing the entities to a "lockbox." But as the subprime crisis worsened and calls to work with borrowers or restructure loans grew, that non-controlling role came under fire. "Other than passive management became very much required," the FASB chairman said. "The use of those entities with those kinds of assets were stressed beyond the original intent."

FASB, however, will also be taking a fresh look at its 46R at mid-week. That interpretation had provided regulatory exemptions for the Qs, a form of "variable interest entity" discussed in the interpretation. Now, however, the board plans require that VIEs previously accounted for as Qs in Statement 140 will need to be analyzed for consolidation.

The board also plans to eliminate a provision that allowed entities to ‘look-through’ to the rights of beneficial interest holders (for example, the investors in mortgage-backed securities held in the Qs) when analyzing who controlled the holdings in the Q. The board is also working on a separate project to gauge how VIEs that were previously Qs should consolidate their assets and liabilities.

On another matter, Herz clarified his position on the issue of how far fair-value accounting should go. Asked if he thought issuers should provide fair-value accounting across the entire balance sheet, he said: "I don't think we should be rushing toward universal fair value for non-financial instruments." But fair value is particularly apt for such items as assets held for sale and contingent liabilities, he said, noting about the latter that "most contingent items are financial instruments and so would be best using fair value."